Externalities and Unbalanced Regional Distribution of Foreign Direct Investment: the Case of China

This paper investigates the spatial determinants of Foreign Direct Investment (FDI) at the provincial level in China. Pecuniary externalities and technological externalities are two important aspects that cause concentration of FDI in China. In this paper, we examine the resulted unbalanced regional distribution of FDI in China's provinces, municipalities and autonomous regions (hereafter provinces) from the above two aspects. The innovations of this paper are: First, on the basis of two sources of externalities, we further investigate the role of another indicator of technological externality innovation efficiency. Second, this paper refines the study of Wang and Fan (2008) and empirically investigates the substitution between the degree of export openness and potential market scale of domestic provinces in the three regions. We use the panel data sets from 1999-2007 in China's 30 provinces and find that in attracting FDI, the domestic regional markets and foreign markets have some substitutions effects for one another in the national, the Eastern and Central provinces sample, but this kind of substitution effect is not found for the Western provinces. The study also reveals the amount of FDI attracted in the Eastern and Central provinces and regions, shows a U-shaped curve with the local innovation capability, and shows that once the model has been correctly set, innovation efficiency can also significantly attract FDI.